COVID-19: Private Markets Impacts - Distressed Debt
Updated: Sep 14, 2020
Strategies to ride out the COVID-19 storm or exploit its consequences
The COVID-19 crisis’ operational, pricing and origination impacts on:
in conjunction with
Distressed debt strategies are not wholly unaffected by the crisis and whilst attractively countercyclical, must nevertheless be resistant and responsive to events beyond an investor’s control. In particular the slew of government interventions, including fiscal support and legislation to protect borrowers from debts being called in or seizure of assets, can change the distressed investing landscape materially – Please CLICK HERE for Octane's summary of key relevant legislative situations developing across Europe
Octane has aggressively stress-tested in some depth existing assets, demonstrating their robustness. Critically, no leverage is used in this strategy, meaning that the team remain in full control of these assets.
Octane Capital specialises in Western European Non-Performing Loans, insolvency portfolios and special situations, with a particular focus on smaller deals (€5-50m) from small and mid-sized local banks. Unlike larger players, who tend to focus on auctioned portfolios, Octane’s counter-parties tend to be proprietary and repeat business from year to year. As such they have an intimate knowledge on the situations developing with local banks across the continent. Here are some key observations on how the COVID-19 crisis is affecting banks, their customers/borrowers and the potential for distressed debt.
Post 2008 it was 6 months after the crisis struck that the NPLs started to become available. Post COVID-19 crisis breaking, Octane expect a quicker turnaround eg 3 months, which would mean possibly June/July 2020 for this. Nevertheless one can infer from the substantial comments on the forward pipeline below that attention is very much on new asset origination, which is expected to continue to grow significantly in this opportunity set.
Meanwhile most businesses in the target European markets are still currently trading, being supported by governments, so it’s still too early (April) to tell as to the broad or precise nature and volume of assets that will appear in Octane’s sweet spot, but the team are expecting significant flows.
Real estate backed non-performing loan portfolios: managers such as Octane who acquired NPL real estate backed portfolios with significant discount to fair, intrinsic value and do not use any form of leverage are in the position that: (i) at no point in time, under no scenario can any collateral be appropriated and (ii) they are never a forced seller of any assets. A hold-to-maturity approach and very limited exposure to hotels, restaurants, leisure or flexible work-space providers means Octane feels comfortable with its exposure.
Insolvency claim portfolios: We consider Octane’s insolvency claim exposure to be very robust due to the cash backed nature of the asset class, the disconnect to any underlying operational business and the resulting very low correlation to any traditional asset classes like public or private equity, bonds, loans or commodities. Again, Octane acquire insolvency claim portfolios without using any leverage.
A full stress-test of the existing portfolio has revealed no material downward revision to expected cashflow amounts. The team have nevertheless prudently extended their assumptions on the timeframe over which some cashflow streams are expected to be received
Pretty much all earnings forecasting is impossible atm. The situation is calming down and now, after an initial hiatus, banks will begin looking at releasing existing non-performing loans (as they will only now and in the near future understand better the degree of non-performance).
There is some potential for slowdown in cash receipts from transactions that involve court proceedings where the courts may not be acting as efficiently as normal.
Bank counter-parties have been initially focused on providing new facilities to help their borrowers through the tough times in the short term. Attention will now begin to turn to those borrowers the bank believes are unlikely to be able to avoid defaulting on repayment promises.
New Asset Origination
Octane expects (and is already seeing) a significant increase in attractive investment opportunities from the NPL, insolvency claims and LBO debt sectors.
This will continue to increase further over time – we are of the opinion that all focus economies are just at the beginning of very severe economic adjustments.
Octane are currently seeing some deep discounted opportunistic deals available from banks, but will likely pass on these as most are nearly impossible to underwrite with any confidence at the moment.
Octane are also re-visiting prior transactions with their counter-parties that they’ve previously declined and considering offering new pricing. This new pricing typically targets an increased minimum 20-25%+ IRR underwriting, in line with policy now for all new deals.